Ryanair hits an air pocket

No-frills airline Ryanair is juggling spending increases with a long-term rise in labour costs. That's bad news for its business model. Alice Grhns reports.

Ryanair is supposed to be "the airline every passenger loves to hate, but keeps using anyway", says Lionel Laurent on Bloomberg. After all, one can forego "a comfy pillow or complimentary peanuts" when the flight costs so little. CEO Michael O'Leary has long been able to dismiss complaints by highlighting the group's "ever-growing traffic numbers". Along with his "fierce discipline on costs", that has kept investors happy. But now Europe's biggest airline has encountered major turbulence.

A rare drop in annual profits

On Monday the stock slipped by nearly 7% as the airline reported a 20% year-on-year drop in profits to €319m in the first quarter, despite a 9% rise in sales to €2.08bn. O'Leary blamed this on strikes and the threat of future labour disputes, which discouraged customers from booking flights and forced Ryanair to lower fares. At the same time, Ryanair is targeting 200 million customers by 2024, up from 130 million. That means more investment "at a time when competitors are slashing fares and expanding aggressively themselves". Add in the prospect of higher wage bills to placate staff and rising fuel prices, and it's no wonder Ryanair investors "are braced for a very rare occurrence: a drop in yearly earnings". Earnings per share for the year to March 2019 are expected to fall by 6%.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The first-quarter results were "dented by one-off problems that will probably fade", says Aimee Donnellan on Breakingviews. But rising staff costs, if they are here to stay, challenge the low-cost business model. Staff costs are €6 per passenger at Ryanair, compared with €9 at easyJet. Strike action has helped pilots achieve a 20% five-year pay rise. As a result, "cabin crew may be hoping to win similar pay awards even though the company insists it won't concede to unreasonable demands".

Labour still accounts for just 12% of Ryanair's overall costs, says Lex in the Financial Times, so "the impact of pay rises on profitability remains minor." But the direction of travel is clear. O'Leary last year recognised pilots' unions through gritted teeth, and will now allow talks with cabin crew unions. If dealing with unionised labour forces becomes the norm, "then there is risk to efficiency longer term". In such a tight labour market, where experienced pilots can earn €300,000 a year working in China, "Ryanair has little choice but to play nicely". To add insult to injury, easyJet has just raised its annual profit estimate for the year to October 2018, says Alistair Osborne in The Times. It's probably "banking on some of Mr O'Leary's guests".

Britain's ten most-hated shares

These are the ten most unpopular firms in the UK, based on the percentage of stock being shorted (the "short interest"). Short-sellers aim to profit from falling prices, so it can be useful to see what they're betting against. The list can also highlight stocks that might bounce on unexpectedly good news when short-sellers are forced out of their positions (a "short squeeze"). The AA and Petrofac are the latest entries. The motoring group has issued a profit warning and slashed dividends, while Petrofac is awaiting the outcome of a corruption investigation.

City talk

"When are the next stock-picker-of-the-year awards?" asks Nils Pratley in The Guardian. Mike Ashley of Sports Direct has written down the value of the sports retailer's near-30% stake in Debenhams by £85m, a sum equivalent to just over half Sports Direct's underlying pre-tax profits last year. According to Sports Direct, supposed "strategic investments" of this kind are based on "active dialogue" with management teams though the dialogue clearly went nowhere in this instance. "I will be smashing into them about why they don't do anything Sports Direct suggests," Ashley said last week.

"Buck up or break up. It's a message GlaxoSmithKline must find uncomfortably familiar," says Lex in the Financial Times. Fund manager Neil Woodford campaigned for a new strategy before dumping his shares last year: now others are "stepping up pressure for change" and propose spinning off the consumer division. It could fetch at least £22bn. Consumer health also has lower margins and little overlap with the pharma business, yet CEO Emma Walmsley (pictured) is right to be cautious. Consumer medicines throw off plenty of cash and can be a hedge against the risks inherent in innovative medicine. Why "rush a sale of the consumer division before the pharma business gets stronger"?

Shopping-centre giant Hammerson is "fiddling while its investment case burns", says Aimee Donnellan on Breakingviews. In March, CEO David Atkins rejected a 635p-a-share offer from France's Klpierre: he said he preferred to bulk up Hammerson in the UK via a takeover of Intu Properties. Then"he got cold feet about the UK market and ditched that deal too". Now the share price is down to 530p.